I believe @ChpBstrd is a regular user of collars
Bat signal received.
Yes,
@Bear Stache I think collars are a good way to protect your retirement portfolio heading into a rate-hiking campaign, because such campaigns are typically associated with bear markets. However, your plan to only collar 200 shares of SPY is not going to sufficiently protect your portfolio from sequence of returns risk (SORR).
The issue is that a deep bear market early in one's retirement can reduce the entire portfolio to the point that withdraws deplete it over time faster than gains replenish it - and we're talking about 20 years later. Earlyretirementnow.com has studied several simulated trajectories from bad years to retire like 1929 or 1965. The general picture is that you need to be insuring yourself against a gut punch in the next few years that puts your portfolio into a death spiral that will not become apparent for a very long time. Portfolio failure cases all look the same: You retire and then experience several years of bad returns and then the remains of the portfolio slowly deplete over the course of many years. If you only insure your first year or two of spending, the rest of the portfolio is still vulnerable. Why not collar a whole 90+% stock portfolio and sleep well at night?
The cost to collar all or most of a portfolio is relatively low, or can be zero, especially if you can (1) buy/sell the options with lots of duration - like 2 or more years - rather than collaring month-to-month, (2) try to acquire the collar in a period when volatility is low, and (3) roll up the duration roughly every year as volatility low points are reached.
You want lots of duration because bear markets ("SORR events") typically last over a year, and you don't want your insurance policy to expire in the midst of a crisis. If that happened you'd have to buy put options at a time when they are inflated in value. Plus, you don't want to collar month-to-month because you'll just have to continually adjust your insurance protection lower and lower as the stock market grinds lower and lower over the course of potentially years. You may have experienced lower volatility, but you'll find you didn't actually achieve the goal of locking in gains. Finally, the best time to buy insurance is before a hurricane warning is issued. If you can get into a collar when volatility is low (e.g. VIX < 17), you'll actually see it gain when volatility rises, particularly if you left yourself more upside than downside, as you'd like to do. Of course the inverse is true too. In the long run this is a small effect, and so I wouldn't recommend waiting too long before setting up the collar, but collars do go on sale periodically.
You may choose to pay a small amount of extra money so that your collar has more upside than downside. This is not a bad idea, particularly when volatility is low and when you're trading options with 2+ years duration. In a sense, it's the cheapest upside you'll ever buy! However keep in mind that time decay will have a bigger effect on your expensive put options than it will on cheap, far-OTM put options. So if you "tilt" your collar this way there will be a slightly negative amount of time decay because the expensive put will decay faster than the cheap call, all things being equal. This is not a major decision point, but it is something to consider. When you start your collar with a put that costs about the same as what you received from the call (a costless collar) the net time decay is zero, but such collars typically have more downside than upside.
Strategically, your plan might look like this:
1) Trade a 2 year collar on SPY with X% upside and Y% downside. The upside and downside should be determined by your risk tolerance for one year. E.g. "I can survive up to a 15% loss, and I'd feel lucky if I gained 10% in one year."
2) One year from now, this collar will have one year duration left. When markets are calm, exit each position and trade into new positions with 2y left, resetting your expectations for upside and downside potential based on where markets are at that time. If markets have gone down, you will receive a fat profit from closing your first collar, and you'll want to apply that toward leaving yourself more upside on your second collar so that you don't miss most of the recovery. If markets have gone up, you'll exit your first collar at a loss, just like with car/home insurance, and start over with a new one. It is important to not let a series of "losing" collars demoralize you, because they are insurance policies that work by allowing you to hold a more aggressive AA even when they don't pay off. Insurance always costs money, and it's usually a good idea to pay it!
3) OPTIONALLY, you could set a rule for yourself in your written IPS where if SPY drops a certain amount from it's all-time-high, let's say 30%, you will exit the collar options for a profit, reinvest the profits into stock, and hold your stock unhedged. This would be a major coup if you could drop your hedge at a profit in the midst of a bear market, and then ride the recovery back up unhedged and with extra long exposure. The statistical odds support this strategy. But you might regret dropping the hedge if there were still 15% downside to go. Even worse would be if you dropped the hedge, experienced further unhedged losses, and then capitulated right before the recovery.
4) OPTIONALLY, you could buy a 2y+ put option and pay for it over time by selling shorter-duration calls more frequently to harvest extra time decay. This makes sense if you expect lots of volatility in the next year, to prop up call prices and increase their time decay, and if you are overall bearish. The downside is the risk of getting assigned during one of the rallies that are common in bear markets, or if you were wrong to be bearish in the first place. If this happens and you have to buy back in at higher prices, you could lose money despite the protection you bought with the put!
